Earnings Call Transcript - LX Q2 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to the LexinFintech Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your first speaker today, Ms. Mandy Dong, Head of IR of Lexin. Please go ahead.

Mandy Dong, Head of IR

Thank you, Amber. Good morning and good evening, everyone. Welcome to Lexin's second quarter 2024 earnings conference call. Our results were issued earlier today and can be found on our IR website. Joining me today are our CEO, Jay Xiao; CRO, Arvin Qiao; and CFO, James Zheng. Before we get started, I'd like to remind you of our safe harbor statement in our earnings press release, which also applies to this call. During the call, we may refer to business outlooks and forward-looking statements, which are based on our current plans, estimates, and projections. The actual results may differ materially and we undertake no obligation to update any forward-looking statements. Last, unless otherwise stated, all figures mentioned are in RMB. Jay will first provide an update on our overall performance. Arvin will discuss risk management updates. Lastly, James will cover the financial results in more detail. I will now turn the call over to Jay. Please kindly note, different from the past, Jay will give his whole remarks in Chinese. Then, the English version will be delivered via Jay's AI-based voice. Jay, go ahead, please.

Jay Xiao, CEO

Good morning and good evening, everyone. I am pleased to share our performance for the second quarter of 2024. In light of the current macroeconomic environment and industry conditions, we have implemented a careful and consistent business strategy focused on risk management and data analytics. Throughout the quarter, we effectively managed our loan origination base, tightened credit standards, and observed a gradual improvement in overall risk levels, alongside a steady increase in profitability. During this quarter, the total loan origination volume reached RMB51.1 billion, with a managed loan balance of RMB115.2 billion. Our revenue was RMB3.64 billion, marking a 12.3% increase quarter-over-quarter, while net profit rose to RMB230 million, up 12.4% compared to the previous quarter. In recognition of our performance in the first half of the year, the Board of Directors has approved a cash dividend distribution of approximately US$0.072 per ADS, continuing to provide value to our shareholders. Now, let's delve into our business performance in the second quarter. In terms of risk management, we successfully balanced business growth with asset quality, optimizing our existing assets and enhancing profitability. Consequently, asset quality has improved, especially for newly issued assets, as we actively implemented our effective low and grow strategy, ensuring stringent control over the quality of new assets while increasing the share of high-quality users. Our efforts included optimizing the RTA model and bidding strategies across major acquisition channels, resulting in a more than 40% rise in the share of high-quality acquisition channels. Additionally, we applied a low and grow strategy to set low credit line admissions and dynamically adjust limits according to user performance, which increased the approval rate while keeping risk levels manageable. We utilized differentiated pricing and credit scoring to target users with minimal risk at the approval stage, leading to an expanded volume of high-quality new assets while minimizing overall asset risk. Consequently, the approval rate for new customer credit applications fell by 20% compared to Q1, while early risk indicators for new customer assets decreased by 23%, and the share of high-quality asset volume rose by 8%, contributing to a shorter payback period for new customers. Regarding the management of existing assets, we moderately enhanced repayment reminders and optimized overdue deduction strategies, resulting in a 7% decrease in the day-one delinquency rate by the end of the second quarter compared to the start of the quarter. For our tail-end customers, we adopted measures such as transaction control and limit reductions to mitigate long-term risk losses and enhance profitability. By automating the management of high-risk users, we significantly improved the speed and precision of our strategies for addressing these accounts. In our efforts to strengthen quality management capabilities, we further advanced our risk management system encompassing data, models, analysis, monitoring, and strategies. Our Chief Risk Officer will provide additional details in the next session. The measures we've implemented for managing newly issued assets, existing assets, and core capabilities have collectively reduced the risk associated with newly issued assets, resulting in a decrease in overall asset risk from its peak. By the end of the second quarter, the day-one delinquency ratio had declined by about 7%, with the 30-day collection rate increasing by approximately 1.5%. Reflecting on our risk management initiatives over the past year, it is evident that the credit cycle within the loan facilitation sector that began in the latter half of last year significantly impacted the industry. Our prior risk management capabilities were not adequately aligned with these market shifts. However, after extensive upgrades to both our risk management team and systems at the beginning of the year, we have noted a substantial enhancement in our risk management capabilities and overall business resilience. Although achieving significant growth in scale and profitability may take time, we anticipate that our improvements in risk management capabilities will progressively bolster our profitability. Turning to our overseas operations, the Mexican market demonstrated rapid growth in the second quarter, with loan origination volume rising by 61% and revenue increasing by 113% quarter-over-quarter. Additionally, our funding costs dropped by 58 basis points compared to the first quarter, reaching a new low. In May and July, we successfully issued bonds totaling RMB600 million, which attracted considerable interest from high-quality investors. As domestic interest rates continue to decline, we plan to pursue differentiated partnerships with more financial institutions that have complementary risk profiles, striking a balance between risk and scale to enhance returns. In the second quarter, we invested RMB143 million in research and development, deepening our application of AI large models. In telemarketing and loan collections, the accuracy of real-time intent recognition improved significantly. The intent recognition accuracy of our telemarketing robots reached 98% in the second quarter, while in collection scenarios, it was 91%. Furthermore, engineering staff utilized the AI large model for code assistance, which enhanced both the efficiency and accuracy of their coding work. Our innovative ventures in AI large models led to Lexin receiving a technology award from The Asian Banker in the second quarter. Regarding consumer rights protection, we further digitized our customer service in the second quarter, enhancing standards and verification processes to swiftly identify and address customer concerns and optimize communication mechanisms. These improvements aim to enhance the customer service experience from the outset and better protect consumer rights. Looking ahead to the second half of the year, we will continue to uphold prudent principles, prioritizing risk management and focusing on key initiatives.

Arvin Qiao, CRO

Thank you, Jay. I would like to provide an update on risk performance for the second quarter. In the second quarter, we maintained our focus on enhancing risk management and improving profitability. We worked on fortifying our risk management system and capabilities. By improving our risk identification processes, developing a comprehensive lifecycle risk management strategy, enhancing our monitoring and detection abilities, creating automated systems to promptly address risk alerts, and implementing refined risk management practices for both new and existing customers, we successfully reduced overall risk levels for both newly issued and total assets in Q2. Notably, the FPD7 rate for new assets dropped by around 14% compared to Q1. The day-one delinquency rate for total assets at the end of Q2 fell by approximately 7% from the start of the quarter. Furthermore, the 30-day collection rate improved by about 1.5 in absolute value since the beginning of the quarter. We expect this trend of decreasing risk levels to persist in the second half of the year. To detail some of the measures we implemented in Q2, we intensified our acquisition of high-quality scenario-based data and conducted customized joint modeling, while discontinuing ineffective third-party data sources. This has built a strong data foundation for our risk management efforts. In terms of our model system development, we optimized and upgraded our risk assessment models across different business lines and partnered with new collaborators who have proprietary ecosystem data, which enhanced our data diversity. We consistently refined our sample selection to better represent our current customer base, ensuring adequate coverage across various customer segments. Additionally, we increased the use of deep learning algorithms, significantly enhancing the performance and stability of our models. By integrating more data and innovating our algorithms, we have iterated various models, including profiling, response, and fraud detection models, resulting in ongoing improvements in both coverage and accuracy. For our management strategy, we established a comprehensive lifecycle risk management system across different business lines, enhancing the precision and effectiveness of risk management at each customer lifecycle stage. In monitoring and detection, we initiated an automated asset risk inspection system, which can identify specific portfolios and quickly pinpoint risk trends and anomalies for rapid response. For managing high-risk customers, our disposal strategy robot has been fully integrated across various business scenarios, bolstering our automated capacity in managing these customers and generating disposal strategy recommendations promptly, thus enhancing efficiency and accuracy in dealing with high-risk assets. In regards to risk management for new customers, we fully implemented a low and grow strategy across all customer acquisition channels, marking a significant upgrade from our former practices. This approach involves offering an initially small credit line while dynamically adjusting it at different stages of the customer lifecycle to effectively mitigate first-time delinquency risks. For quality customers managing to advance in their lifecycle, we increase their credit limits to support growth in high-quality assets. This complete rollout of our new strategy has resulted in a credit approval rate rise of roughly 20% compared to Q1, while the early risk indicator, FPD7, for new customers decreased by 23% relative to Q1, establishing a solid groundwork for attracting high-quality customers and supporting business growth. For risk management of new assets from existing customers, our focus in Q2 centered on three areas: managing high-risk assets, optimizing structure, and differentiated pricing. In managing high-risk assets, we restructured entry and transaction stages. During entry, we applied differentiated products according to risk levels, and at the transaction stage, we provided real-time risk information to facilitate agile decision-making, leading to a 20% reduction in risk levels for existing customers compared to Q1. We also lowered credit limits for customers with mismatched profiles, reclaiming credit exposure and effectively reducing long-term risk. Our automated asset inspections and risk strategy robot hastened early warnings and disposal of medium- to high-risk assets. For structural optimization, we raised credit limits for high-quality customers based on our advanced risk identification capability, which effectively enhanced the share of high-quality GMV. We also ramped up reoffer initiatives for customers showing signs of churn or those who had stopped using our services, aiming to re-engage them. In terms of differentiated pricing, we bolstered our capabilities across all product lines, resulting in a steady increase in the take rates of each product line compared to Q1. Looking at collection efficiency for existing assets in Q2, we concentrated on three main areas: expanding the coverage of third-party debit transfers, refining the debit transfer strategy, and improving pre-delinquency reminders. These efforts were effective, leading to a gradual rise in the collection rate for existing assets. Moving into the third quarter, we plan to continue enhancing our risk identification capabilities, risk strategy systems, and the upgrades of our intelligent risk management tools. Furthermore, we aim to deepen the differentiation in our risk management capabilities by segmenting based on customer cohorts, products, and scenarios. We will also strengthen collaborations with various financial institutions to align with diverse risk preferences and strategies. Our objective is to ensure that the risk levels for both new and existing assets continue to decline in the third quarter, promote the growth of high-quality assets, optimize asset structures, and gradually enhance profitability.

James Zheng, CFO

Thank you, Arvin. I will now give a more detailed update on our financial results. Please note that all figures are presented in RMB, unless otherwise stated. As Jay and Arvin mentioned, in the second quarter, the macroeconomic recovery remained sluggish. Consumer confidence continued to be at historical lows. In this context, we maintained a cautious operating strategy, controlling the pace of loan issuers and further tightening credit standards. This timely adjustment strategy not only brought us healthy financial results but also laid a solid foundation for future growth. The strong financial performance in the second quarter can be highlighted in the following four aspects. First, significant increase in revenue take rate. This is the key highlight of the quarter. The revenue take rate of the credit business rose to 2.91%, an increase of 37 basis points quarter-over-quarter and 54 basis points year-over-year. Despite a 12% quarter-over-quarter decline and a 20.1% year-over-year decline in quarterly loan issuers, we achieved a 12.3% quarter-over-quarter and a 19.1% year-over-year revenue growth. The increase in take rate was primarily driven by record low funding costs, risk-based differentiated pricing optimization, a slight refinement in the early repayment ratio, and a continuous improvement in the asset quality of new loans. Arvin detailed the downward trend in risks of new assets, and we're confident that we will see more improvement in the overall loan portfolio later this year. Secondly, record low funding costs and more balanced funding channels. In the second quarter, funding costs further declined to 5.26%, down 58 basis points quarter-over-quarter and 131 basis points year-over-year. This significant drop in funding costs was due to a relaxed monetary policy environment, increased market demand for high-quality assets from our platform, and efficiency improvement brought by diversified funding sources. We successfully resumed ABS issuance in May after a break of more than two years, and in July, we issued a second ABS this year with the funding cost for the senior tranche as low as 2.8%. Moving forward, we plan to issue ABS regularly to further diversify our funding sources and reduce overall funding costs. In the second quarter, we added two new financial institutions as funding partners, maintaining approximately 70% of our funding from national institutions. Thirdly, a small increase in the risk-free new loans. The percentage of new loans in the risk-free segment of total GMV increased from 23% in Q1 to 27.2% in Q2. The risk-free segment mainly consists of new loans facilitated by the risk-free profit-sharing model and tech empowerment SaaS services to banking partners. Additionally, the revenue split proportion in the profit-sharing model increased by 1 percentage point quarter-over-quarter and 4 percentage points year-over-year. These increases enhanced our risk-free revenue quality and helped improve profitability. The increase in share proportion was due to growing demand for high-quality assets in the financial market and the gradual improvement in our overall asset quality. This demonstrates that our risk management capabilities are increasingly recognized. Also, as a side note, in the portion of risk-free revenue, we are also exploring value-added services offered to our customers to improve user experience. Fourth, strong recovery in e-commerce business. In the second quarter, e-commerce business revenue surged to RMB437 million, up 88.5% quarter-over-quarter. Gross profit in e-commerce rebounded from a loss in the first quarter to RMB14 million in the second quarter. The total transaction volume in e-commerce increased by 3.3% quarter-over-quarter, indicating an improvement in the revenue take rate and profitability. This turnaround was mainly due to decisive measures taken in previous quarters to reduce risk levels and upgrade risk management strategies. Despite short-term disruptions in the first quarter, business growth and profitability quickly recovered and returned to the growth trajectory, a trend we expect to continue. In addition to the above four operational highlights, I would like to add some details regarding the income statement. First, on revenue. Technology-enabled services revenue grew to RMB535 million in the second quarter, up 47.9% quarter-over-quarter, driven mainly by increased GMV in risk-free loans, higher revenue share proportion, and other services. Second, on cost and expense items. The total provision cost in Q2 increased by 12.6% quarter-over-quarter due to higher risk levels in the existing loan book. However, as Arvin mentioned, during the second quarter, we saw an improving trend in the day-one delinquency rate, which peaked in April and gradually came down from April to June. Additionally, the increase in the 90-days-plus delinquency rate was mainly due to a quarter-over-quarter decline in the loan balance, driven by lower new originations and the lapse of time. The 90-plus-day delinquency ratio only serves as a lagging indicator and provides one angle to review the risk performance among various metrics. While the risk profile for new loans has substantially improved, the risk for existing loans has also stabilized. However, the provision for the total portfolio will still have some lingering effect in the coming quarters. Second, funding cost. The on-balance sheet loan amount and funding cost remained relatively stable due to the flat size of trust funding. Third, processing and service costs decreased by 11.7% quarter-over-quarter due to a reduction in loan issuance and facilitation volume in the second quarter. Fourth, sales and marketing expenses increased by 12% quarter-over-quarter, primarily due to investments in expanding overseas markets as our base in Mexico is rapidly expanding. This increases customer acquisition costs, although the domestic customer acquisition remains stable. Fifth, the net profit margin. Despite the challenges in the second quarter, our net profit margin remained stable compared to the first quarter. Lastly, regarding the balance sheet items. In the second quarter, we strengthened our cash position to RMB4.6 billion through refined operational efficiency and maintained solid shareholders' equity of over RMB10 billion. Regarding shareholders' return, as Jay mentioned, we are committed to creating sustainable value for shareholders and have announced a cash dividend of US$0.072 per ADS for the first half of 2024, equivalent to approximately 20% of the total net profit for the first half of 2024. Based on the current share price and our annualized cash dividend payout, the cash dividend yield reached about 8.7%, which we believe is in the top range among ADR companies. Looking ahead to the third quarter, amid continued uncertainty in the macroeconomic recovery, we will continue to adhere to a prudent operating principle. Based on current forecasts, which are subject to managerial updates, we expect total loan issuance and profit in the third quarter to remain at similar levels compared to the second quarter. That concludes the financial segment.

Operator, Operator

We can now open the floor for questions.

Yada Li, Analyst

Hello, management. Thank you for taking my questions. Mr. Jay mentioned that the growth of the overseas business this quarter far outpaced overall business. Could you provide more details on the overseas expansion and when we expect the overseas business to scale up in volume and generate profit? Additionally, the management noted that the company continued a prudent strategy this quarter, but we observed an increase in sales and marketing expenses compared to the first quarter, which suggests that the customer acquisition cost per active user has also risen. Could management provide more insights on this? That's all. Thank you.

Jay Xiao, CEO

In Q2, in light of a slow macroeconomic recovery, we adopted a cautious approach in the domestic market, tightening our risk approval standards and maintaining a healthy, controlled scale of loan origination. Our overseas business, however, has been growing quickly. Total loan origination in Q2 rose by 60.8%, and the loan balance increased by 76.8% from the previous quarter, significantly exceeding our overall business growth. Additionally, the overseas business is accelerating its growth rate with quarter-on-quarter growth in Q2 being approximately 2 to 3 times that of Q1. Nevertheless, we should note that the scale of our overseas business remains relatively small compared to our domestic operations. We expect that it will take time and further investment to expand and eventually become profitable. Therefore, we plan to increase our investment in the overseas market to expedite our expansion. Regarding your question about sales and marketing expenses, most of the additional costs stem from investments in overseas markets, which are currently in a high-growth phase that requires substantial funding. If you look at the financial statements alone, it might seem like the customer acquisition cost per active user has risen, but that’s not the complete picture. Our analysis shows that the total cost of acquiring new customers in the domestic market has remained stable relative to Q1, which aligns with our expectations. Furthermore, as we enhance our efficiency in customer acquisition domestically, we anticipate an improvement in the quality of our customer base, leading to a shorter payback period and a gradual reduction in unit costs per customer.

Mandy Dong, Head of IR

Operator, that answers the two questions of Yada. We can move to the next questions.

Zoe Zou, Analyst

Okay. Let me translate. First, as James mentioned, even though loan volume decreased this quarter, revenue increased quarter-over-quarter, indicating a notable rise in the revenue take rate. Can management detail what has driven this change and provide insights on the expected future trends of the revenue take rate? Secondly, both the CEO and CFO spoke about a significant reduction in funding costs this quarter. Could you provide more details on the specific actions taken to lower funding costs and share management's perspective on the trend of funding costs for the upcoming third quarter and the rest of 2024? Thank you.

James Zheng, CFO

Thank you, Zoe. I will answer your questions. The first question, in Q2, due to the slow recovery of the macro economy, we continued to adopt a prudent strategy. Basically, total loan origination declined by 12% and the loan balance dropped by about 5% quarter-over-quarter. However, due to our focus on improving operational efficiency and strengthening core capabilities, the revenue take rate increased significantly from 2.54% in Q1 to 2.91%. This is a substantial rise of 37 basis points quarter-over-quarter and about 54 basis points year-over-year. This increase is due to several reasons, including tightened risk standards which improved new loan quality this quarter, a significant reduction in funding costs, further optimizations of early repayment ratios, risk-based differentiated pricing, and additional value-added services. Looking ahead to the third quarter, we will continue with our prudent operational strategy, and we expect the revenue take rate to maintain slight upward momentum in the near future. Regarding the second question about funding costs, this quarter, the funding cost reached a new record low at about 5.26%, decreasing by 58 basis points quarter-over-quarter. This significant reduction is driven by various factors. First, overall liquidity in the market remains relatively ample, and our quality assets are in high demand among funding partners, which reflects our improving asset quality gaining recognition from funding partners. Secondly, our profit-sharing model saw the revenue split ratio increase by 1 percentage point quarter-over-quarter and 4 percentage points year-over-year, demonstrating our assets' competitiveness and strong bargaining power. Thirdly, the continuous issuance of ABS, as both Jay and I mentioned, saw us issue two tranches of ABS, with the senior tranche as low as 2.8%, significantly bringing down our funding costs. We plan to regularly issue ABS to further diversify our funding channels. Additionally, in Q2, we added two more funding partners to our existing network of 160 partners, maintaining the proportion of funds from national funding partners at about 70%. Looking ahead, with the acceleration in ABS issuance and continuous improvement in asset quality, if overall market liquidity remains sufficient, we believe there is considerable room for further reduction in funding costs in the near future. Hopefully, this answers your questions.

Operator, Operator

Thank you. Our next question comes from the line of Alex Ye from UBS. Please ask your question, Alex.

Alex Ye, Analyst

I have two questions regarding asset quality. First, after observing some initial signs of improvement in both new loans and the overall portfolio, when can we expect this improvement to be reflected more significantly in our bottom line in the future? My second question is about some risk indicators. The 90-days-plus non-performing loan ratio has increased to 3.7% in Q2. When do we anticipate this figure will start to decline? Additionally, in terms of the 30-days vintage curve, we have observed that the Q1 curve continues to follow the pattern of previous quarters. When can we expect to see improvements in that area? Thank you.

Arvin Qiao, CRO

As we continue to enhance our risk management strategies, we will further strengthen our risk identification capabilities, advance the construction of a comprehensive lifecycle risk management system, improve our risk monitoring and early alert capabilities, and develop intelligent risk tools, such as the strategy robots we mentioned. We anticipate that the proportion of new loans will gradually increase while the risk level of existing assets declines, leading to an improvement in profitability in the future. We expect this to manifest as gradual quarterly improvements over time. The 90-days delinquency rate acts as a lagging indicator. We strongly suggest that the market pay more attention to leading risk indicators that we monitor daily in our risk management efforts. These indicators include the FPD7 for newly issued assets, which dropped about 14% compared to the first quarter; the day-one delinquency rate for total assets, which decreased about 7% from the peak in April to June in the second quarter; and the M1 collection rate, which gradually improved by about 1.5% from April to June. All improvements in the risk associated with newly issued assets will gradually reflect in the 90-days rate over time. It will take time until we see improvements in the 90-days delinquency rate. Additionally, the increase in the 90-days delinquency rate can be explained mathematically by the drop in loan balance, as we actively restrained loan origination in Q2. This decrease in loan balance results in a smaller denominator, which naturally leads to an increase in the 90-days delinquency rate. With ongoing upgrades in risk management, we expect to see a downward trend in risk in the second half of the year.

Mandy Dong, Head of IR

Well, Alex, hope that addressed your question regarding risk management. Operator, if there are no more questions on the line, I think we can close the call.

Operator, Operator

Thank you. I'm showing no further questions. I'll now turn the conference back to the management team for closing comments.

Mandy Dong, Head of IR

Thank you, again, everyone for joining us today. If you have further questions, please feel free to contact us via the contact information on our IR website. Thank you all. Have a good day and good night.

Operator, Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.